It sounds stupid and harmless enough: players are bidding on a dollar. As per usual auctions, the highest bid wins the dollar.

But the twist is what makes it evil: the second-highest bidder also has to pay.

The wiki article does not do justice to what usually happens in the dollar auction: you get a bidding battle between two people and it can end in blows. I forbade the Dollar Auction being played around me at Mathcamp, because I knew how corrosive this “game” was.

Forget about rationality. What happens is if you have two people who must win, they will bid up past $1 on that dollar up for auction. The wiki article talks about “rational” strategy, but just like in War Games, there is only one rational choice:

I could say the darkness in men’s souls is what makes the Dollar Auction bad; I could blame it on the devil; I could blame it on the stupidity of humanity in general. It’s all the same.

Does it actually batten down and start to make full pension payments? Does it reconsider the pension benefits?

And by “it” or “the government” I mean the very human people who are making decisions on behalf of said entity.

I used this visual in the last POB post: the Illinois Teachers Retirement System balance sheet history:

You can barely see it, but there was a POB between 2003 and 2005. It barely made a dent in the unfunded pension liability.

And what then? In the ten years since 2005, Illinois underfunded the TRS pension fund by at least a billion dollars a year.

With regards to contributions, there was a choice on the part of the “government”.

With regards to all the other reasons for shortfalls — investment experience, experience in salary changes and longevity — the government had less direct control. But they definitely had a choice with regards to how much of the budget to apply to the pensions.

And every damn year, the Illinois government made a conscious decision to shortchange the pension. That was not an accident.

POBs are most often used by governments that were shortchanging the pensions, or goosing the benefits in insane and seemingly sane ways, to paper over said shortchanging. This farce lasts only so long.

The former chairman of Goldman Sachs once called Pension Obligation Bonds “lousy public policy.”

They’re “the dumbest idea I ever heard. It’s speculating the way I would have speculated in my bond position at Goldman Sachs,” said Jon Corzine, who left Wall Street to serve as governor of New Jersey.

…..
“What politicians are doing is nothing other than borrowing money to buy stocks, taking a bet on the stock market,” said Andrew Briggs, who tracks retirement policy at the American Enterprise Institute, a conservative Washington, D.C.-based think tank.

“There’s no reason to believe state and local governments have any particular insight into the stock market,” he said.

Briggs suggested that politicians and pension trustees are enticed by POBs by the accounting gains they create, and not merely prospective returns.

…..GASB standards allow pension funds to immediately claim an improved funding ratio once the cash is borrowed. That, in turn, means lower annual contribution requirements, which takes the strain off state and local budgets.

“And all that takes place before they’ve earned a penny of the higher returns they’ve assumed. It’s a dumb move from a longer-term perspective,” said Briggs. “But politicians don’t care about the long term.”

You’ve got to realize what people like me and Briggs mean by the long term: we’re talking decades. At least 30 years.

Generally, politicians aren’t around that long. When they are, like the old Mayor Daley, they can learn to jump ship once all the fun money dissipates.

I elided over all the bad thinking — the sure debt of 5% in POBs for the supposed good-as-sure 8% returns the pension funds are supposed to yield.

Bullshit.

The point is that it’s a fake bolstering of the balance sheet — the debt is still there, but now it’s in the form of bonds, and the debtor is not the pension fund but the state (or other government employer) itself. But the pension fund debt was the state’s debt to begin with.

Only accounting magic makes the debt look smaller than it actually is. And the debt to the pension fund is actually larger than originally stated. Now the state has two creditors: the holders of the POBs and the pension fund. That sounds more like the dollar auction now.

The POB debt is “sure” — the state is supposed to pay off the interest and the principal. The pension debt is less sure, but somehow it seems to grow even faster after this particular POB trick.

And the only states that feel the need to avail themselves of this particular trick tend to have gotten in their position by bad behavior, and they’re not about to change their behavior after the POB is issued.

This is why I say POBs are of the devil — whether or not you believe in a literal devil, the literary devil is the kind that helps you rationalize the bad behavior you already did and are determined on continuing.